Helping You Navigate Turbulent Times
Issue 25/15 for June 23, 2015
CONTRARY TO POPULAR BELIEF, A CRISIS DOES NOT USUALLY
CAUSE A MAJOR PROBLEM FOR THE ECONOMY OR MARKETS.
Last week’s Update was entitled “Do Rising Interest Rates Really Matter.” I
pointed out that higher interest rates on their own, are not usually negative for the
markets. I also said, “…conditions may change enough by September that a rate
increase may not be warranted anymore…” After writing that Tuesday evening
and having it approved Wednesday morning, it was emailed to you 30 minutes
before the Fed announcement came out at 11:15 am Pacific Time. Interestingly,
the announcement changed peoples view so that the percentage of investors
expecting the Fed to raise interest rates in September has now declined from 60%
to 40%. You heard it hear first.
The other major topic dominating the business headlines has been the
deplorable debt situation in Greece. Greek leaders and the ECB have been playing
a game of chicken for months now as debt repayment deadlines are approaching
within days. English writer, Samuel Johnson (1791) wrote, “When a man knows
he is going to be hanged in a fortnight, it concentrates the mind wonderfully.” The
deadline Greece has with the ECB and the IMF to decide whether or not they
remain in the Euro has a similar affect. It seems like Greece has blinked by
willing to offer some concessions that were not on the table before. All sides now
seem more optimistic and history suggests there should be some sort of
compromise at the last minute. Nevertheless, there is still no assurance that a deal
will be reached. What will be the consequences if Greece defaults on its debt and
leaves the Eurozone?
If we take the time to look back at history, we can see how human
beings/investors have responded to similar crises in the past. Fairly recent events
like the September 11, 2001 terrorist attacks and the 2008 Financial Crisis make it
appear as though a crisis or unexpected event causes major havoc in the economy
and the markets, but history actually presents a different verdict. On the following
page, I have noted many of the major crisis or unexpected events since 1941, and
have separated the events where the DJIA was up after 12 months from the
incidents when the Dow Jones Industrial Average was down after 12 months.
While some may debate what is included and excluded, there are 26 incidents
when the DJIA rose after 12 months compared to 11 when the DJIA declined.
Why did stocks rise after many unexpected events and decline after others?
Why did equities fall 9.8% after the Berlin Wall came down in 1989, which was a
positive event, yet rise 21.1% after the Chernobyl nuclear meltdown? Let me
answer that with a comment that may seem like a broken record. It is profound
nevertheless.
The U.S. yield curve inverted in 1989 when the Berlin Wall came down,
resulting in a U.S. recession, which dragged down the DJIA. Why did the DJIA
fall 17.8% after President Reagan was shot and slightly wounded in 1981, yet rise
21.6% after President Kennedy was assassinated in 1963? Because the yield curve
inverted and oil prices had increased by 80% in 12 months by early 1981.
Why did the DJIA fall 35.2% when U.S. Vice President Spiro Agnew resigned
due to the Watergate Scandal in 1973, yet rise 18.6% after President Clinton was
going to be impeached in 1998? Oil prices rose more than 80% in 12 months in
1973.
Why did the value of the DJIA increase by 33.3% after the Long Term Capital
Hedge Fund was bailed out in 1998 and fall 39.6% after Bear Stearns failed and
the U.S. government arranged a take over in 2008? The yield curve inverted in
July 2006 and oil prices rose 80% in 12 months as of April 2008.
History seems to point out something we find hard to accept. In many cases a
crisis is not that negative for the economy or the markets. When we think of the
uncertainty regarding Greece, it is interesting to look back and see that the DJIA
rose 9.2% in the year after the British Sterling fell in 1992. U.S. stocks rose 34.8%
after the Mexican Peso hit an air pocket in 1994 and 17.2% 12 months after
several Asian currencies collapsed in 1997.
Russia defaulted on its debt in 1998, which was a surprise. Yet the DJIA was
up close to 30% 12 months later. History shows that markets and economies can
handle a crisis or unexpected event most of the time, just like the human body can
handle all the viruses that are floating around us all the time. However, when the
markets and the economy are under severe stress due to an inverted yield curve
and/or a big spike in oil prices, they are likely to suffer. If a crisis occurs at a time
like that, it will usually just shorten the time before the suffering and pain occurs.
The same thing happens in our bodies. If we are stressed out, tired, not eating well
and not exercising, viruses are much more likely to take hold and make us sick.
In conclusion, whatever happens with Greece should not cause a major longterm problem with global economies and markets since the yield curve is not
inverted and oil prices are much lower than they were a year ago.
FYI, Zimbabwe was once the breadbasket of Africa. While taking property from
the landowners and giving it to the locals may have seemed like a good idea at the
time, it has turned into a colossal disaster. Imagine inflation reached 1,000,000%
so that a loaf of bread cost Z$1,000,000 one year and 1 million times that the
next! There is no word to describe $1,000,000,000,000. Unemployment is now at
80%. What a disgrace! That is why this boy is not being mugged and robbed.
Like President Robert Mugabe in Zimbabwe, Hugo Chavez became a folk hero
for distributing wealth in Venezuela. Now annual inflation has reached 510%
there. These experiments work for a short time, but not a long time before there is
much more misery and personal suffering than there was before.
On a lighter note, monster truck Max D has been the first to successfully perform
a double back flip last weekend. What some people are able to do these days is
utterly amazing. The bar is being raised in many ways in some countries.
Regarding market reactions to a crisis, here is a table from InvesTech Research
showing the reactions to a war or political event. The yield curve inverted in July
2000 and oil was up 80% in 12 months in 1999, which is why markets declined
16.8% after September 2001. This was the only 12-month decline since 1941.
This is a study of smaller companies (represented by the Russell 2000 Index)
done by Oppenheimer on June 22, 2015. They looked at times when the Russell
2000 has broken out to new all-time highs when it was up less than 10% in the
previous 52 weeks like it has now. They discovered when this has happened in the
past, the S&P 500 has risen 7.9% in the following 6 months on average, as
compared to the normal average of 4.9%. For the following 12 months, the S&P
500 has increased an average of 15% compared to the average 12-month gain of
10% for all periods. They point out that the current situation is similar to 1995.
Isn’t that interesting. A number of previous Updates have pointed out that the
average gain for the DJIA in a year ending in five is far above average. RBC
Technical Analyst Robert Sluymer points out that the DJIA has been up 9 out of 10
times since 1905 (in years ending in five) with an average gain of 31%. The S&P
500 has been positive all 8 years ending in five since its inception with an average
gain of 25%. If 2015 is going to follow that pattern, there are only six months left
to produce the bulk of a 31% return for the DJIA. (It is almost flat so far this year.)
It will be very interesting to see if this will repeat. The higher level of pessimism
and fear in recent weeks has produced a healthier environment for stocks to rise.
Have a great week!
Dave Harder, CIM, FCSI
Vice President and Portfolio Manager
RBC Dominion Securities
604-870-7126
Toll Free 1-866-928-4745
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